Zoetis Inc. (NYSE:ZTS) Q1 2023 Earnings Call Transcript May 4, 2023

Zoetis Inc. beats earnings expectations. Reported EPS is $1.31, expectations were $1.26.

Operator: Welcome to the First Quarter 2023 Financial Results Conference Call and a Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-in or on the Investor Relations section of zoetis.com. [Operator Instructions]. It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin.

Steve Frank: Thank you, operator. Good morning, everyone, and welcome to the Zoetis first quarter 2023 earnings call. I am joined today by Kristin Peck, our Chief Executive Officer; and Wetteny Joseph, our Chief Financial Officer. Before we begin, I will remind you that the slides presented on this call are available on the Investor Relations section of our website and that our remarks today will include forward-looking statements and that actual results could differ materially from those projections. For a list and description of certain factors that could cause results to differ, I refer you to the forward-looking statements in today’s press release and our SEC filings, including, but not limited to, our Annual Report on Form 10-K and our reports on Form 10-Q.

Our remarks today will also include references to certain financial measures, which were not prepared in accordance with Generally Accepted Accounting Principles or U.S. GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable U.S. GAAP measures is included in the financial tables that accompany our earnings press release and the company’s 8-K filing dated today, Thursday, May 4, 2023. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Kristin.

Kristin Peck: Thank you, Steve, and welcome everyone to our first quarter earnings call for 2023. Today, we reported solid first quarter results of 4% operational growth in revenue as expected, based on our diverse portfolio and strength in international markets. As we indicated in February, we expected a softer first quarter and a stronger growth for the remainder of the year, and we are reiterating our full year guidance for operational growth of 6% to 8% in revenue and 7% to 9% in adjusted net income, given the underlying strength of the petcare market. In the first quarter, our international segment led the way growing revenue 10% operationally and was partially offset by a 1% decline in the U.S. Our livestock portfolio drove the results with 12% operational growth in revenue, while companion animal product revenues were flat operationally.

The performance in livestock was based on double-digit operational growth for cattle, poultry, sheep and fish. In the case of U.S. cattle, this performance was supported by an improvement in the supply of key products. Meanwhile, our companion animal portfolio in the U.S. declined due to distributors destocking and reducing their inventories in the first quarter. As well as higher purchases in the fourth quarter of 2022, which occurred in anticipation of price increases and based on promotional programs. We see strong end market demand in companion animal channels based on data from veterinary clinics, retailers and pet owners. And we view distributor inventories as a short-term impact on our companion animal sales. For example, while our sales into distributors declined in the quarter, as we expected, our product sales from distributors out to veterinary clinics were up approximately 8% and our product sales out of retail channels to pet owners were up about 35% up affirming a healthy petcare market in the U.S. Pet owner demand for product is expected to grow during the second quarter, pulling through more inventory and allowing purchase patterns by distributors to become more aligned with the underlying demand throughout the year.

Other dynamics in the U.S. vet clinics also continue to show momentum and trending in a positive direction. Clinic visits increased 2% in the first quarter, showing an increase for the first time since 2021. Meanwhile, clinic revenue and average spend per visit continue to grow even in the face of inflationary pressures. Revenue and average dollars per visit increased 11% and 9% respectively in the quarter. The combination of evolving pet owner demographics, innovative medicines and an unbreakable human animal bond, all continue to support a positive and growing companion animal market where we lead. Despite the Q1 distributor issues in the U.S. our overall growth was driven by strength in international markets, which delivered 10% operational revenue growth in both livestock and companion animal portfolios.

This quarter’s results are a testament once again to how our diverse portfolio and geographic presence help deliver steady and predictable growth. Turning now to adjusted net income, we saw a decline of 3% operationally in the first quarter, which was in-line with our expectations. The first quarter reflected significant investments in our U.S. petcare field force and shifts in the go to market model for diagnostics, costs which were not incurred fully in the year ago quarter. We also saw increased investments in R&D, which we have discussed previously. The investments in diagnostics are maturing and gaining traction in the U.S., and we continue to grow and expand outside of the U.S. We expect a return to growth in U.S. diagnostics for the year as we build our Vetscan Imagyst AI platform, refine and grow our reference lab business and bring further innovative offerings to the space.

Looking ahead, we see strong demand driving double digit operational growth for our innovative companion animal portfolio and relatively flat operational growth in our livestock portfolio this year. We will continue to invest in the franchises and capabilities that support our future growth, including large and growing product areas like parasiticides, dermatology, monoclonal antibodies, vaccines and diagnostics. For example, we continue to build out key product franchises through lifecycle innovations and claim extensions in products like Simparica Trio, Cytopoint and Draxxin. We are also expanding our global reach with approvals in additional markets for new livestock vaccines like Protivity, for beef and dairy calves, and Lawsotek for swine.

And most recently, we purchased a manufacturing site outside Atlanta, Georgia, which will be used as a new monoclonal antibody, vaccine, and petcare product operation to add capacity for expected growth. As you know, our monoclonal antibody and vaccine platforms are rapidly growing and this new site would substantially expand manufacturing capacity for our biologics portfolio and ensure long-term supply across all global markets when it begins operations in 2026. While the overall economic uncertainty remains a headwind globally in 2020, 2023, we have proven to be up to any challenge. We have learned valuable lessons and built new muscles, especially over the last three years, developing more agility, flexibility and resilience in our business and our people.

Despite the unusual mix of results in our first quarter, I continue to feel very positive about our full year guidance, and how our diverse portfolio and vision for the future of animal health can drive long-term sustainable growth, and create value for our customers and shareholders. We will continue to be disciplined yet adaptable in our approach to the opportunities, potential challenges and economic shifts that could occur throughout the year. We remain committed to delivering strong growth in 2023 based on our market leadership, innovative franchises and diverse portfolio, while continuing to invest for the future. Thank you. Now let me hand this off to Wetteny. Wetteny?

Wetteny Joseph: Thank you, Kristin, and good morning, everyone. We had a solid start to the year, with growth driven by our livestock business and strong international market performance. Echoing Kristin’s comment, our Q1 results are in-line with our expectations. As we indicated on our Q4 earnings call, we expected the first quarter to be below the low end of our forecasted annual operational growth rate of 6% for 2023. In the first quarter, we generated revenue of $2 billion growing 1% on a reported basis and 4% on an operational basis. Adjusted net income of $607 million declined 3% on both a reported and an operational basis. Of the 4% operational revenue growth, 5%age from price with a 1% decline in volume. The volume decline is driven primarily by U.S. companion animal distributor destocking in the quarter.

Our livestock portfolio led the way in terms of species growth growing 12% operationally with companion animal revenues flat on an operational basis in the quarter. Livestock growth was broad based with double-digit operational growth across cattle, poultry, sheep and fish. The growth in cattle was driven by additional supply of key products in the U.S. We saw growth in our poultry portfolio driven by higher sales of vaccines. Our sheep products benefited from favorable market conditions in Australia as well as our acquisition of Jurox in the fourth quarter of 2022. Finally, our fish portfolio continues to perform well with double-digit operational growth driven by strong vaccine performance in Norway. Sales of our companion animal products were flat operationally in the quarter, with growth in our monoclonal antibody products, Cytopoint, Librela and Solensia, offsetting declines in Apoquel, parasiticides and anti-infectives.

Our monoclonal antibodies for osteoarthritis pain in dogs and cats, Librela and Solensia posted $51 million in revenue globally in the quarter, with strong demand for both products. Additionally, Solensia benefited from our U.S. launch in the third quarter last year. As for Librela in the U.S. we still anticipate approval in the first half of this year with the launch later in the second half. Simparica Trio posted global revenue of $151 million in the quarter, representing an operational decline of 7% versus the comparable 2022 period. This was primarily the result of U.S. distributor destocking during the quarter, as well as pre-price increased buy-in and promotional activity during the fourth quarter. This decline was partially offset by growth in our international markets from increased clinic penetration and launches in new markets.

Our key dermatology portfolio declined 3% percent operation only with $290 million in global revenue. This decline is attributed to the impact of pre-price increased buy-ins in the U.S. in Q4, and in Japan in the comparable period in 2022. Cytopoint partially offset this decline with double-digit growth based on continued veterinary preference for injectables, which keep revenues in the clinic. Cytopoint better reflects underlying market demand due to our direct sales model on our dermatology portfolio and the lack of retail channel impacts. While we do believe conversion from Apoquel to Cytopoint may be accelerating, our overall outlook for our key dermatology portfolio remains unchanged. Our companion animal diagnostics portfolio declined 3% operationally, with declines in the U.S. partially offset by growth internationally.

Now moving on to revenue growth by segment for the quarter. U.S. revenue was $1 billion in the quarter declining 1% with companion animal products declining 7% and livestock sales growing 15%. Companion animal performance in the quarter is reflective of the expectations we set in the prior quarter and is a result of distributor inventory and promotional impacts. As Kristin mentioned, demand for the veterinary market as demonstrated by distributor sales to clinics is healthy and growing. We continue to see robust sales outgrowth across our companion animal portfolio, including strong growth in parasiticides and our key dermatology products and our outlook for the full year remains unchanged. U.S. vet practice trends are improving, with clinic visits up 2% in the quarter and clinic revenue growth up 11%.

Average revenue per visit is up 9%. These trends are slightly better than we expected and largely reflect the normalization of the COVID impact on vet clinic visits. Total visits in the quarter remain above pre-pandemic levels and clinic revenues have grown on average of 10% annually over that period. Spent per visit remains elevated as the standard-of-care continues to increase. Turning to product performance, the companion animal decline in the U.S. was driven largely by a decrease in sales of our parasiticides portfolio as well as key dermatology products. Simparica Trio posted sales of $127 million in the quarter, declining 13% driven by distributor destocking, partially offset by growth in patient share where we continue to outpace the overall flea, tick, and heartworm market.

Our outlook for Trio remains unchanged as we continue to see strong customer demand and continued conversion from topicals and collars. Key dermatology products sales were $184 million for the quarter declining 5%. Apoquel sales were negatively impacted by high sales in Q4 ahead of our 2023 price increases and significant retail buy-in in Q1 2022. Cytopoint sales growth partially offset the Apoquel decline due largely to its injectable administration, which is preferred by clinics. The U.S. companion animal decline was partially offset by growth in sales of Solensia, which launched in the third quarter. We continue to see solid clinic penetration growth in Solensia and expect to drive awareness of feline OA through our DTC advertising campaigns.

U.S. livestock grew 15% in the quarter, primarily resulting from our cattle business where we have improved several supply outages, which impacted our revenues throughout 2022 and replenished our channel partner inventories. While we will continue to see benefit from improved supply, the replenishment impact is largely isolated to this quarter. We also saw growth in Synovex due to expanded label claims. Our poultry business also contributed to growth driven by expanded sales of vaccines. Moving on to our international segment, where revenue grew 3% on a reported basis and 10% operationally in the quarter with companion animal and livestock revenue both growing 10%. Increased sales of companion animal products resulted from our monoclonal antibodies for alleviation of osteoarthritis pain, small animal parasiticides, as well as the impact of our Jurox acquisition, which was completed in the fourth quarter of last year.

We continue to be encouraged by the performance of Librela and Solensia. Librela generated $34 million or 74% operational growth driven by strong underlying demand and the removal of supply allocations that were in-place for the first half of 2022. Solensia delivered $9 million in the first quarter sales internationally, driven by stronger demand. Simparica Trio was the top contributor to growth for our international small animal parasiticides with $24 million in revenue growing 47% operationally due to expanding market share in the flea, tick, and heartworm space. Our international key dermatology portfolio was flat operational in the quarter. We saw double-digit operational growth across most of our major markets, driven by higher compliance and new patients.

However, this growth was offset by large pre-priced buy-ups of Apoquel in Japan in Q1 2022. Our international livestock segment also grew 10% operational in the quarter with growth in four of our five core species. Growth was driven by our cattle portfolio, which benefited from price increases in certain emerging markets. Our sheep business had an exceptional quarter with high demand in Australia due to favorable market conditions as well as the impact of our Jurox acquisition. Poultry also contributed to growth in the quarter with higher key account penetration in the Middle East and Eastern Europe as well as the benefit of price. And lastly, our fish portfolio continues to perform well, driven by growth in salmon vaccines in Norway. Swine was flat for the quarter with strong sales in China, partially offset by intermittent supply constraints in some markets.

Now moving on to the rest of the P&L for the quarter. Adjusted gross margins of 70.8% declined 80 basis points on a reported basis compared to the prior year, resulting from higher manufacturing costs and unfavorable product mix. This was partially offset by favorable foreign exchange and price increases. Adjusted operating expenses increased 12% operationally with SG&A growth of 11% operationally driven by headcount related compensation costs as a result of our U.S. small animal field force expansion, which largely began in Q2 of 2022, and higher T&E. R&D grew 19% on an operational basis, driven by higher project spend for our pipeline candidates, advancing projects include disruptive, novel innovation and lifecycle management. R&D remains our first priority in capital allocation.

Other income and deductions in the quarter are reflective of a favorable benefit associated with a settlement in the current period for prior period underpaid royalties related to sales of certain products. The adjusted effective tax rate for the quarter was 20.5% an increase of 160 basis points driven by lower net discrete tax benefits in the quarter and less favorable jurisdictional mix of earnings, partially offset by higher benefit in the U.S. related to foreign derived intangible income. And finally, adjusted net income declined 3% operationally and adjusted diluted EPS declined 1% operationally for the quarter. Capital expenditures in the first quarter were $223 million. We are still anticipating a significant increase in capital expenditures for the full year of 2023.

We continue to make investments to support our future growth, including manufacturing capacity for monoclonal antibodies as well as oral solid dosage. In the quarter, we repurchased $283 million of Zoetis shares and grew a dividend over 15% versus Q1 2022. Now, moving on to guidance for the full year 2023. As we have mentioned, the first quarter has gone largely as we expected. We are therefore reaffirming our 2023 guidance provided during February’s earnings call. Note that guidance reflects foreign exchange rates as of late April. Foreign exchange rates have been volatile over the quarter. We will continue to monitor the impact of this volatility going forward. For the year, we continue to expect revenue between $8.575 billion and $8.725 billion representing a range of 6% to 8% operational growth.

We also continue to expect adjusted net income to be in the range of $2.49 billion to $2.54 billion representing operational growth of 7% to 9%. And finally, we expected this adjusted diluted EPS to be in the range of $5.34 to $5.44 and reported diluted EPS to be in the range of $5.03 to $5.14, both consistent with our February guidance. Just to summarize before we go to Q&A, we remain confident in our ability to deliver on our full year guidance commitments and expect more normalized growth in subsequent quarters. We continue to see positive trends and solid fundamentals in the underlying demand and are confident that our innovative portfolio will continue to allow us to go in-line with or faster than the market. Now, I’ll hand things over to the operator to open the line for your questions.

Operator?

Q&A Session

Operator: [Operator Instructions]. We’ll take our first question from Jon Block from Stifel. Please go ahead.

Operator: And we will take our next question from Erin Wright with Morgan Stanley. Please go ahead.

Operator: And we will take our next question from Michael Ryskin with Bank of America. Please go ahead.

Operator: We’ll take our next question from Nathan Rich with Goldman Sachs. Please go ahead.

Operator: And we will go next to Louise Chen with Cantor. Please go ahead.

Operator: And we will take our next question from David Westenberg with Piper Sandler. Please go ahead.

Operator: And we will take our next question from Balaji Prasad with Barclays. Please go ahead.

Operator: And we’ll take our next question from Chris Schott with JPMorgan. Please go ahead.

Operator: And we’ll take our next question from Brandon Vazquez with William Blair. Please go ahead.

Operator: And we’ll go next to [Steve Scholar with PD Cohen] (ph). Please go ahead.

Operator: And there are no further questions at this time. I’ll turn the program back to Kristin Peck for closing remarks.

Kristin Peck: Thank you. So look, just to summarize, we really see a very positive and sustainable demand for our product based on what we’ve talked about for long time which is the fundamental drivers of animal health. We are confident that Zoetis has the industry’s most diverse and durable global portfolio. And this is really founded on innovative science as we talk about and supported by a high quality supply chain. We’ll remain focused this year and going forward on our five key growth catalyst; dermatology, pet parasiticides, pain, diagnostics and emerging markets. And we’re going to continue to invest in the talent, the pipeline and the capabilities that support this future growth while ensuring that we can adapt to the dynamic environment that we all operate in.

And we really look forward to sharing more about this with you. Our vision, our pipeline, our strategies for growth at our Investor Day on May 25th. And there you’ll hear more from me, Wetteny, our Head of R&D, Rob Polzer, about the confidence we have in the animal health industry. And importantly, our ability to go faster than that market and the investments that we’re making to create that value for our shareholders. So, we announced the event this week and I hope you can all join us virtually or at the New York Stock Exchange. As always, you can find more details about our Investor Relations information on our website. So thanks so much for joining us today.

Operator: Thank you. This does conclude today’s program. Thank you for your participation. You may disconnect at any time.